A retailer is posting strong earnings growth in its bricks-and-mortar business. But its fledgling Internet operation is losing money.
Should Wall Street analysts ignore those losses and focus only on the profitable business in making their earnings estimates? Or should they look at the company’s retailing operations as a whole, which means lowering their bottom-line forecasts to reflect the dot-com losses?
That is the crux of a battle with broad repercussions among a growing number of companies, analysts and First Call/Thomson Financial, whose survey of analyst predictions is one of Wall Street’s main yardsticks for measuring quarterly results.
The behind-the-scenes conflict heated up as Staples Inc. persuaded many analysts to submit to First Call only estimates for the office-supplies retailer’s first quarter that omitted losses from its Staples.com division.
First Call, meanwhile, threatened to drop the forecasts of analysts who didn’t provide standard net income figures for its influential survey, which is sold to institutional investors. While First Call has become more indulgent in recent years about letting companies and analysts slice earnings the way they see fit, First Call research director Chuck Hill says that excluding Internet losses is beyond the pale.
“It’s not a one-time charge. It’s not a non-operational charge. It’s just open and shut,” contends Hill. “Whoever heard of a company excluding the losses of a majority-owned subsidiary?”
Indeed, the dispute is part of a growing trend by companies to emphasize whatever numbers make them look best — revenue or even the number of Web-site visitors, for example, in the case of money-losing Internet startups.
Established companies with Web businesses, critics say, are trying to have their cake and eat it, too — that is, gaining market recognition for having a sexy Internet side, while not being penalized by the losses.
The dispute over what number to focus on isn’t just cosmetic, but gets to the heart of how investors view the company; beating or missing the analysts’ consensus earnings-per-share estimate by just a few pennies can send a stock soaring or plummeting.
In Staples’ case, if its interest in Staples.com isn’t counted, its first-quarter earnings per share were up 27 percent over year-earlier numbers. Including about $20 million in Internet losses, however, earnings actually fell 9 percent.
Staples Chief Executive Thomas Stemberg says the issue is “more complicated” than First Call believes. It doesn’t make sense for investors eyeballing earnings growth to see the development of an Internet business reflected as a negative, he maintains.
“I don’t want to be perceived as deceptive,” Stemberg says. “It’s all right there for everyone to see. It’s just a question of how it’s presented.”
Staples notes that the Staples.com losses are included in its audited financial statement, as required by generally accepted accounting principles.
Staples is far from alone in trying to readjust expectations in the Internet age.
Other old-line concerns investing heavily in Web operations to catch up with Internet upstarts are finding their losses are piling up, creating unfavorable comparisons with year-ago figures. That is leading many to start releasing figures without the losses — and to feature those figures more prominently than net income in their news releases.
Staples and Walt Disney Co. have created separate tracking stocks for their Web businesses, and others are considering such a move; still, in such cases in which the main company keeps a majority interest, auditors require that any share of Internet losses must be included when reporting earnings.
Other companies, including Toys “R” Us Inc., Viacom Inc. and its majority-owned Blockbuster Inc. unit, have no tracking stocks, but are highlighting income sans Internet businesses — almost always losses — in their news releases and conference calls.
Most retailers, including Wal-Mart Stores Inc., lump their Internet results in with everything else. .
Hill of First Call acknowledges that the firm may have unwittingly opened the floodgates for disputes over what to include in and exclude from analysts’ estimates by letting analysts and companies adjust the ground rules in other cases. For example, for about 100 companies, First Call accepts analysts’ forecasts of “cash earnings”; this excludes the write-down of goodwill from acquisitions that otherwise would have made the earnings look dismal. “I let majority rule on (that) one,” says Hill.
But he contends that losses of Internet operations are a different matter. In fact, he says he had little trouble persuading Toys “R” Us and Blockbuster analysts to give him forecasts including the Internet operations.
But when he tackled Staples, threatening to pull analysts from its survey unless they submitted forecasts that included Internet losses, a battle ensued. Staples called analysts and “asked them to pull” the consolidated forecasts, says Credit Suisse First Boston analyst William A. Julian. He complied to please Staples, but continued including the total results in his reports, because he feels that is what investors want to see.
PaineWebber analyst Aram Rubinson, however, refused to go along with Staples’s request. “You don’t want to encourage retailers to go out and lose money in one side of the business because the Street is not going to focus on it,” he says.
Stemberg of Staples says one of the complicating factors is that investors looking at the standard net income results will become very confused in future quarters as Staples begins to reduce its ownership of Staples.com. While the nonWeb business, now called Staples Retail and Delivery, or RD for short, currently has an 88 percent interest in Staples.com and thus includes 88 percent of the Internet losses in its income statements, some of the losses will disappear from income statements as more shares are sold to outside investors.
“In each quarter you change the numbers and make your comparisons irrelevant because the percentage owned is changed,” explains Stemberg. Staples has filed for an initial public offering of Staples.com stock, but for now its shares aren’t available to the public; the other 12 percent currently is owned by a group that includes Staples employees.
Staples says it wasn’t trying to quash the consolidated forecasts — it just objects to the fact that those numbers are the first thing investors see when they type in the company’s ticker symbol on First Call. First Call also carried the without-Internet numbers, but they were hard to find for someone who didn’t know they were there.
After Staples called to complain, Hill allowed analysts to post the excluding Internet numbers through the end of the quarter. However, now he is enforcing his previous ruling, and so far 11 of the about 18 analysts covering Staples have given him the numbers he wants. “If analysts don’t give us numbers including, they ain’t going to be in the tables,” he says. Staples said it will keep reporting the Web and non-Web results separately as long as the Internet portion is reflected in a separate tracking stock. If Internet valuations fall, the company might eliminate the separate stock. “Tracking stock structures are reversible,” Stemberg said.
Despite the separate reporting of the Internet numbers, Staples’ valuation has suffered from the losses. “If you look at the stock, you’ll see they haven’t fooled anyone,” says Martin B. Bukoll, an analyst at Northern Trust Global Investments, one of Staples’s major shareholders. “Investors are well aware of the increased spending in the Internet business, and investors have said they don’t really like it.” The retailer’s stock was trading Monday at about $16, well off its 52-week high of $32.75 last July.
